Is it time to end GDP as we know it?
The World Bank just published a new book The Changing Wealth of Nations 2018 which tracks the wealth of 141 countries between 1995 and 2014.
According to the report;
Human capital accounts for two thirds of global wealth, the largest chunk of wealth. The report shows that human capital is about 70% of the wealth in high-income countries and only 40% in low-income countries. Human capital is computed as the present value of future earnings for the labor force, factoring in education and skills as well as experience and the likelihood of labor force participation at various ages. This report makes a clear economic case for investing in human capital to boost wealth and future economic growth.
GDP being flawed in many ways to measure progress of nations is well known by now;
The report argues that wealth is a better judge of economic success because it measures the flow of income that a country’s assets generate over time — although it is significantly more challenging to measure. “A country’s level of economic development is strongly related to the composition of its national wealth,” the report states.
Wealth includes all assets, which means human capital (the value of earnings over a person’s lifetime), natural capital (energy, minerals, agricultural land), produced capital (machinery, buildings, urban land), and net foreign assets.
Assessing an economy by GDP instead of wealth is like looking exclusively at a company’s income statements without considering the assets on its balance sheet. A company can make its income look good for a short time by liquidating assets, but over the long run this will reduce the firm’s productive capacity and other means of generating income in the future.
The same applies to a country. GDP “does not reflect depreciation and depletion of assets, whether investment and accumulation of wealth are keeping pace with population growth, or whether the mix of assets is consistent with a country’s development goals,” the report states. That said, for most countries GDP is strongly correlated to wealth.
This year at World Economic Forum, the economist Diane Coyle proposed an alternative complement to measuring wealth;
In recent work with Benjamin Mitra-Kahn, chief economist at Australia’s intellectual property office, we proposed an entirely different kind of approach to measuring economic progress, one grounded in a different understanding of social welfare.
Economics has for over a century rested on utilitarian ethics — anyone who has studied the subject will be aware that people are assumed to maximise their ‘utility’. In terms of the statistics, utility is regarded as being generated by the flow of income and expenditure in any given time period. This explains the well-known paradox that natural disasters look like they are good for the economy, because despite the destruction, they will be followed by an increase in spending. The fact that it is spent on repairing damaged houses and roads does not register.
Instead, we are proposing basing the measurement of economic progress on the Nobel economist Amartya Sen’s concept of ‘capabilities’. The question he posed was: what do people need to allow them to lead the kind of life they want? This is most naturally measured in terms of access to several kinds of assets. Do they have financial capital? But also human capital (education and skills), physical capital (infrastructure such as roads, housing), intangible capital (examples include patents, goodwill, or data), natural capital (clean air, green space, a healthy ecosystem), and social capital (a well-functioning community or nation)?
Diane Coyle’s book on GDP and her blog should be starting point for all interested in learning about GDP and it’s measurement.
For Discussion: Besides the books below, what additional books and reports can you suggest regarding measurement issues of GDP and its alternatives?
Related Assorted:
Diane Coyle, follows in the footsteps of a recent Review of UK Economic Statistics (2016) and her own Brief (But Affectionate History) book on GDP. The current System of National Accounts was developed in the 1940s for an economy dominated by the production of goods (with an increased predominance of manufacturing). That leads naturally to the approach used to measure GDP: it is basically the value added created in the market economy. Most importantly, home production is excluded from GDP. However, the public sector is included but measured by inputs rather than outputs. In her book, Diane Coyle explains how that choice was made, against the views of Simon Kuznets. In her presentation today, Diane Coyle shows convincingly that the conventions pertaining to the definition of the boundary of production are quantitatively relevant.
Michal Kalecki, the Polish economist, is said to have described economics as “the science of confusing stocks with flows”. Investors scrutinise a company’s balance sheet as well as its profits and losses. Yet, when it comes to sizing up a nation, we are mostly stuck with GDP, which counts the value of goods and services produced in a given period.
- An ambitious project to measure the wealth of nations shows how GDP is a deceptive gauge of progress
- Good-bye, GDP. Hello, six-part balance sheet?
